In recent weeks, it has become clear that both the US and European economies are confronted with a secular rise in inflation significantly beyond the levels anticipated at the start of 2022. In our paper ‘US vs. Europe inflation – Same, but different’,we explain why we see significant differences in the nature of inflation risk between the US and the eurozone and what these mean for the policy response with which investors should reckon.
In our view, on account of a significantly larger output gap and greater slack in labour markets, the European Central Bank is not about to embark on a cycle of rate rises of the same magnitude that we expect from the Federal Reserve.
While the European labour market is tightening, real wage gains are unlikely to outpace productivity gains by much – wage increases will be part of the price finding adjustment rather than the trigger for a wage-price spiral.
In the US, in contrast, the acute shortage of workers is far more conducive to a wage acceleration that could lead to significant pass-through and second-order effects. Correspondingly, while the ECB may take its foot off the accelerator in coming months, we think the Fed is far more likely to be the central bank that needs to tap the brakes.
Nevertheless, with the ECB, Federal Reserve and Bank of England now all heading towards a wind-down of their balance sheets and higher policy rates, investors should prepare for higher real yields and a reversal of portfolio balance effects.
